Special Situation Investing

Friday, August 25, 2006

Bally Total Fitness (BFT) -- Hedge Fund Activism

Bally Total Fitness (BFT) has entered a confidentiality agreement with Hedge fund Pardus Capital Management. According to the article:

Pardus said in a filing with the Securities and Exchange Commission on Thursday that Bally will give Pardus "certain nonpublic information about the company for the purpose of evaluating and negotiating a possible strategic transaction with the company."

Under the terms of the agreement, Pardus can nominate individuals for election to Bally's board of directors; bring business before a stockholders meeting; and conduct a proxy solicitation in support of director nominees, according to the filing.

This is just another chapter in a long battle to repair the heavily indebted company. A brief timeline of events follows:

August 24, James F. McAnally resigns after 10 years.

August 11 - the CEO resigns. Don Kornstein is appointed interim Chairman, Barry Elson is appointed as acting CEO. Side note, Don Korstein apparently worked in the investment banking department of Bear Stearns. Pardus and Liberation Investments is in support of the new management. While independant, Pardus and Liberation own approximately 25% of outstanding shares and have a vested interest in cooperating and driving change in the company.
- the company announces that plans for a sale or merger have fallen through
- operating income is forecast to drop by 10-20% year over year
- filing of the quarterly report is postponed

March 21 - The company received a temporary lift when it was announced that
Richard Branson's Virgin Group was interested in acquiring the company. It is now known that this deal fell through.

September 2005 - The company announced that it would sell it's Crunch Fitness Club to help pay down debt. This sale eventually went through.


Bally Total Fitness is faced with interest payments which generally exceed operating income. On top of this, operating income has begun to decline. Without large scale operational changes or capital restructuring the company faces bankruptcy.

However, with control shifting to the hedge funds, these types of changes are exactly what is in store. In the latest press release, Pardus has indicated that they are interested in strategic alternatives. On August 11th, Liberation increased their stake in the company and had this to say about their intentions:

It also wants to arrange or participate in talks with third parties about a potential purchase of Bally's assets, a reorganization or investment, according to the SEC filing.

Liberation also said it may hold talks with Bally stockholders, management or board to maximize the value of their investment. The moves could include the purchase of additional stock, the sale of its stake or private deals to transfer its shares to another group.


BTF is cheap. It is also near bankruptcy. A few comparison numbers with competitor Life Time Fitness (LTM) illustrate the point (all numbers 12 months ending March 31/06):


P/E: Effectively negative, the company realized a small gain after selling assets but is losing money each quarter.

P/Operating Income: 1.49

P/Sales: ~0.1

P/Tangible Book: -.07 This is better understood in absolute values, a market cap of $106.8 million over -$1.46 billlion tangible assets. However, much of this is Deferred Long Term Liability Charges. The company had $713 million in long-term liabilities, March 31.


P/E : 34.5

P/Operating Income: 18.3

P/Sales: 3.7

P/Tangible Book: 4.8


While I am not quite ready to pull the trigger, at present price the risk/reward ratio seems appealing. Any sort of improvement could lead to a large rally. Consider that the company is currently trading at $2.58, and has ranged from $2.33-$9.92 over the past 52 weeks. It is also worth noting that the market has reacted very mildly to the latest news of Pardus investigating strategic alternatives. Investors seem to have lost faith. That is usually a good time to buy.


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